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Non-Competition Agreements – A Breath of Fresh Air for Employers

By Tim McInturf

The most significant Texas decision on covenants not to compete in more than a decade appears in Alex Sheshunoff Mgmt. Svcs., L.P. v. Kenneth Johnson and Strunk & Assoc., L.P. __ S.W.3d __, 50 Tex Sup. Ct. J. 44 (Oct. 20, 2006).(This case was argued nearly two years ago.)

Sheshunoff is a breath of fresh air for employers who are tired of fumbling in the dark ever since the Supreme Court of Texas decided Light v. Centel Cellular Co. in 1994. Sheshunoff eliminates the split of authority among various Texas intermediate courts, and negates the onerous line of cases that nullified noncompetition agreements where employers agreed to provide confidential information at indefinite points in the future rather than at times certain, such as when the agreements were signed.

Sheshunoff does not eliminate any statutory requirements, however, such as the requirement that the covenants not to compete be ancillary to otherwise enforceable agreements. Therefore, if a covenant not to compete is unrelated to another enforceable agreement, the covenant itself is still unenforceable. However, the Court expressly held that executory contracts—contracts that can be accepted by future performance—are sufficient. This clarification is the key. Now, if employment agreements contain promises by employees to refrain from disclosing confidential information, and in reliance on such promises, employers disclose confidential information to the employees, the employees’ nondisclosure agreements may form the otherwise enforceable agreements to which the covenants not to compete are ancillary. In adopting this view, the Court effectively accepted the Beaumont-Houston line of authority and rejected the Austin-Dallas line.

This good news for employers recognizes that, in adopting and later amending the Texas Covenant Not to Compete Act, the Legislature actually intended to make covenants not to compete easier—rather than more difficult—to enforce. Sheshunoff blames the Court itself for the past confusion by including footnote 6 in the 1994 Light decision.

Sheshunoff brings Texas law more in line with that of other states that require a legitimate or protectable interest (in Texas, it must be an “otherwise enforceable agreement”), along with restrictions that are reasonable and no greater than necessary to protect employers’ legitimate interests.

In the words of the Texas Supreme Court, “the statute’s core inquiry is whether the covenant contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest” of the employer.

Tim McInturf is a shareholder in Littler Mendelson, P.C., who practices in the area of unfair competition and trade secrets. He is a former editor-in-chief of The Houston Lawyer.

“Heads” - Lawyer Wins,
“Tails” - Client Loses

By John Gray

The majority decision from the Supreme Court of Texas described an attorney’s termination fee provision that way in Hoover Slovacek L.L.P. v. Walton, ___ S.W.3d ___ (Tex. 2006) __ Tex. Sup. Ct. J. ___ (_____, 2006).

Mr. Walton signed a contingent fee when he hired the Hoover law firm to recover unpaid royalties from several oil and gas companies operating on his ranch. After Mr. Walton authorized settlement of his claims against Bass Enterprises Oil company (“Bass”) for $8.5 million, his lawyers demanded $58.5 million from Bass with no supporting legal theory or expert report. Bass did not take the demand seriously and countered with a $6 million offer, not only to settle the claims, but also to purchase a number of Mr. Walton’s surface rights, easements and royalty interests. Mr. Walton refused to sell his rights but did authorize settlement of his claims for $6 million. Shortly thereafter, he fired Hoover. His new counsel eventually settled his claims against Bass for $900,000.

After they were fired, Hoover sent Mr. Walton a $1.7 million bill (28.66 percent of $6 million) based on the contract’s termination fee provision that stated:

You may terminate the Firm’s legal representation at any time . . . . Upon termination by You, You agree to immediately pay the Firm the then present value of the Contingent Fee described [herein], plus all Costs then owed to the Firm, plus subsequent legal fees [incurred to transfer the representation to another firm and withdraw from litigation].

Hoover argued that Mr. Walton’s claim against Bass was reasonably worth $6 million when they were fired, even though larger than what Mr. Walton ultimately recovered. A jury found for Hoover and the trial court entered a judgment on the verdict for $900,000. The appellate court reversed and rendered a take nothing judgment and Hoover appealed to the Supreme Court.

The Supreme Court began by stating that, in Texas, attorneys have a special responsibility to maintain the highest standards of conduct and fair dealing with their clients because they almost always have the greater understanding of fee agreements. Thus, the Court places the burden of fair dealing on lawyers when it comes to fee arrangements. When attorneys believe they are unjustly fired, their remedy is to seek compensation in a separate lawsuit for quantum merit to collect a fee from any damages the client subsequently recovers. See Mandell & Wright v. Thomas, 441 S.W. 2d 841, 847 (Tex. 1969). Hoover’s termination fee provision, however, contracted around the Mandell remedies by (1) making no distinction between discharges with and without cause, (2) setting the attorney’s fee as a percentage of the net present value of the client’s claim at the time of discharge, and (3) by requiring payment of the fee at the time of any attorney firing.

The provision required immediate payment of all attorney’s fees (without regard to whether the client eventually recovered anything), imposing an undue burden on the client’s ability to change counsel. The provision created an incentive for lawyers to rid themselves of a client soon after they establish the present value of the client’s claim, instead of trying to obtain the best result for their client. The provision ran afoul of Rules 1.04(d) and 1.08(h) of Texas’ Disciplinary Rules of Professional Conduct. For these reasons, the Court found that the provision was overreaching, unconscionable and unenforceable. Finally, it held that if Hoover believed it was wrongfully terminated, Hoover must rely on remedies found in Mandell.

John S. Gray practices with Gardere Wynne Sewell LLP and is a member of The Houston Lawyer editorial board.

Mold Claims Not Covered in Texas

By Brad A. Allen

The Supreme Court of Texas recently issued its decision that the Texas HO-B policy does not cover mold damage sustained by an insured homeowner’s dwelling. In Fiess v. State Farm Lloyds, Cause No. 04-1104, -- S.W. 3d --, 2006 WL 2505995 (Tex. 2006) the insureds contended that their homeowners’ policy covered mold damage caused by plumbing leaks. The federal district court, where the case originated, concluded there was no coverage for mold damage regardless of the cause. The Fifth Circuit certified the question to the Supreme Court of Texas.

In an opinion authored by Justice Brister, six other justices joining, the Court firmly rejected the idea that the mold exclusion (with an “ensuing loss” clause) was ambiguous. The Court held: “In this case, it is hard to find any ambiguity in the ordinary meaning of ‘We do not cover loss caused by mold.’ While the ensuing-loss clause that follows may be difficult to parse, few ordinary people would imagine that it changes the meaning of the first sentence to read ‘We do too cover loss caused by mold.’”

The Court then addressed the effect of the ensuing loss clause which says “[w]e do cover ensuing loss caused by water damage if the loss would otherwise be covered under this policy” reaffirming Lambros v. Standard Fire Insurance Co., 530 S.W.2d 138 (Tex. App.--San Antonio 1975, writ ref’d), which had held that an ensuing loss clause provided coverage only when the excluded event is followed by an intervening occurrence that in turn caused an ensuing loss. The Court concluded that the ensuing-loss clause in Lambros was indistinguishable from the one in the Fiess’ policy. Consequently, the clause did not provide coverage for any loss caused by the excluded risk itself—the mold.

The Court also emphasized that the ensuing loss clause applied only to ensuing losses from “water damage,” not to ensuing losses from water alone: The Court explained: “Mold does not grow without water; if every leak and drip is ‘water damage,’ then it is hard to imagine any mold, rust, or rot excluded by this policy, and the mold exclusion would be practically meaningless.” Thus, mold was not “water damage,” so the ensuing-loss clause did not apply.

The Court also addressed the clause’s requirement that the ensuing loss “otherwise be covered.” The dissent interpreted the phrase to mean “if the loss would otherwise be covered under this policy not counting the exclusions . . . .” then the resulting mold would be covered. The majority consulted the dictionary definition of “otherwise” and concluded that its meaning did not permit courts to ignore the exclusion language.

The Court noted that Texas rules for interpreting insurance policies do not change simply because potentially harsh circumstances may exist. The Court said: “If the political branches of Texas government decide that mold should be covered in Texas insurance policies, they have tools at their disposal to do so; Texas courts must stick to what those policies say, and cannot adopt a different rule when a ‘crisis’ arises.” The court then answered “No” to the certified question asking whether mold was covered under the Texas HO-B policy. Justice Medina authored a dissent, joined by Justice O’Neill.

Brad A. Allen is a partner at Martin, Disiere, Jefferson & Wisdom, L.L.P. He is a member of The Houston Lawyer editorial board and a former editor-in-chief.

Review Denied on Mold Claims Beyond Fiess

By Brad A. Allen

The Supreme Court of Texas recently denied review of Lundstrom v. United Services Automobile Association, 192 S.W.3d 78, Tex. App.--Houston [14th Dist.] pet. denied.). The Fourteenth Court considered in Lundstrom whether USAA properly denied coverage for the insured’s claims for mold damage to their dwelling and personal property after a loss resulting from a rainstorm.

The insureds argued for coverage of their claims under the “Accidental Discharge, Leakage or Overflow of Water or Steam” peril, and that the policy’s mold exclusion did not apply because of the “ensuing loss” clause. As the Fourteenth Court framed it, “The question is whether the alleged mold damage in the present case is covered under the ensuing loss exception to the mold exclusion.” The appellate court held that it was not, observing that in Lambrosv. Standard Fire Insurance Co., 530 S.W.2d 138 (Tex. Civ. App.--San Antonio 1975, writ ref’d), the San Antonio Court of Appeals determined that “ensuing loss” is a loss that results or follows from the listed excluded risks. The Court noted that, “The mold exclusion in the Lundstroms’ policy parallels the settling exclusion in Lambros.” The Court then held that, “Consistent with Lambros, for the ensuing loss exception to override the exclusion for mold in the present case, the mold must have caused or preceded the water damage, not vice versa.” Observing that the Supreme Court of Texas refused the writ in Lambros (as opposed to merely denying writ), Lambros carries the “same precedential value” as an opinion of the Supreme Court of Texas.

The court then concluded that, “Under Lambros, the mold damage, which followed rather than preceded the water damage in the present case, is excluded from coverage under the Lundstroms’ policy.”

Lundstrom is significant because the Supreme Court’s opinion in Fiess did not address paragraph 9 (Accidental Discharge, Leakage or Overflow of Water or Steam) of the HO-B policy because the insureds failed to appeal that issue. Some will argue Lundstrom is important because it helps demonstrate why Fiess applies to personal property claims.

Lundstrom also remains important because, after holding that the Lundstroms’ breach-of-contract claim failed for lack of coverage, the Fourteenth Court went on to consider and reject all of the Lundstroms’ extra-contractual claims.

Brad A. Allen is a partner at Martin, Disiere, Jefferson & Wisdom, L.L.P. He is a member of The Houston Lawyer editorial board and a former editor-in-chief.

Texas Supreme Court Delivers Rare Victory to Personal Injury Plaintiffs in State v. Shumake

By David V. Wilson II

In an opinion which “bucks the trend” of its anti-plaintiff reputation, the Supreme Court of Texas resolved a split among the intermediate appellate courts by ruling that Texas’ recreational use statute does not reinstate sovereign immunity for premises liability claims arising on state-owned recreational properties. State v. Shumake, 49 Tex. S. Ct. Journal 769 (June 23, 2006). The case arose when nine-year-old Kayla Shumake was drowned while swimming and tubing in the Blanco River in Blanco State Park. In the wrongful death suit against the State of Texas, her parents alleged that the undertow which caused her to drown was created by a submerged man-made culvert. The parents further contended the State knew of this danger because of previous reports of near-drownings.

The trial court denied the State’s plea to the jurisdiction asserting that the recreational use statute barred Plaintiffs’ premises defect claims by eliminating the waiver of governmental immunity provided by the Texas Tort Claims Act for such claims. On interlocutory appeal, the court of appeals affirmed the trial court, concluding that the Shumakes adequately pleaded a premises liability claim and that the recreational use statute dealt with a lower standard of care, not immunity. The Texas Supreme Court granted the State’s petition for review, concluding it had jurisdiction due to conflicting views of the intermediate courts on the same issue.

The State’s logic before the Texas Supreme Court pointed to language at Texas Civil Practice & Remedies Code Sec. 75.002 which provides that the State owes a duty to a claimant injured on State-owned recreational property only the same duty owed to a trespasser. The State contended that by classifying the entrant and user of recreational property as a trespasser, the Legislature reinstated the immunity for premises defects waived by the Tort Claims Act. Its reasoning concluded that because a landowner generally has no duty to warn trespassers of dangerous conditions or make property safe, trespassers cannot complain of such things.

A majority of the Texas Supreme Court disagreed with the State’s logic. First, the Court pointed out that both the Restatement of Torts and Texas common law contemplate circumstances under which a landowner can be liable to a trespasser. In particular, landowners owe a duty to refrain from injuring the trespasser willfully, wantonly or through gross negligence. Second, the Court looked to language in the statute at 75.002(d) which provides it is not intended “to limit the liability of [a landowner] who has been grossly negligent or has acted with malicious intent or in bad faith.” Thus, a landowner can be liable for gross negligence by creating a condition that the recreational user would not reasonably expect on the property in the course of the permitted use. Since the Shumakes’ pleadings alleged just such a condition, they sufficiently stated a premises liability claim under the recreational use statute, a claim which was covered by the waiver of sovereign immunity in the Tort Claims Act. The lower courts were affirmed.

David V. Wilson II is a shareholder with Hays, McConn, Rice & Pickering, P.C. and articles editor of The Houston Lawyer.

Premises Owners and Employers Still Not Liable for Acts of Independent Contractors

By Scott Lemond

In 1976’s Dupree v. Piggly Wiggly Shop Rite Foods, Inc., 542 S.W.2d 882 (Tex. Civ. App.--Corpus Christi 1976, writ ref’d n.r.e.), the Thirteenth Court of Appeals outlined a “personal character exception” to the rule that one who employs an independent contractor is not liable for that contractor’s torts -- the theory being, in securing one’s property, a premises owner owes the public a non-delagable or personal duty. Thirty years later, the Supreme Court revisited Dupree in Fifth Club, Inc. v. Ramirez, 48 Tex. S. Ct. J. 829 (Jun. 30, 2006).

Fifth Club engaged West, a certified peace officer working primarily for Huston-Tillotson College, to provide security at a night club. A club employee signaled West to remove Ramirez. In so doing, West fractured Ramirez’ skull. After a jury found Fifth Club vicariously liable, Fifth Club appealed.

On petition for review, the Supreme Court considered control. A person may be vicariously liable for an independent contractor’s conduct if the person retains control (that “relate[s] to the activity that actually caused the injury”) over the contractor’s work. In Ramirez’ case, “Fifth Club’s action in directing West to remove Ramirez from the premises did not rise to the level of directing how the work was to be performed or directing the safety of the performance . . . .”

Next, the Court analyzed Dupree, rejecting the notion that a duty arises merely because one hires security officers. Dupree was wrongly decided because the reasons other states adopted the personal character exception (a nondelegable duty to keep premises safe, and public policy reasons generally relating to security work) “are not applicable under Texas law . . . .” First, Texas has no laws imposing nondelegable duties on business owners to keep their premises safe. Second, Texas has never expressed public policy concerns that: (i) business owners should not benefit from property protection without also accepting responsibility for unlawful acts of security contractors; or (ii) security work is an activity for which vicarious liability attaches whether the worker is an employee or independent contractor.

Turning to background checks, “[n]egligence in hir-ing requires that the employer’s ‘failure to investigate, screen, or supervise its [hirees] proximately caused the injuries the plain-tiffs allege.’” A background check would have only revealed that West violated Huston-Tillotson’s peace officer manual by accepting employment at Fifth Club and the college reprimanded him for using profanity. These transgressions would not have put Fifth Club on notice that West posed a risk of harm to the pub-lic. To the contrary, West, a licensed peace officer, was uniquely suited for security work. Thus, the Supreme Court reversed the award against Fifth Club, let stand a ruling against West, and overruled Dupree.

Scott Lemond is of counsel in the Houston office of Seyfarth Shaw, LLP, where he concentrates his practice in the areas of litigation and labor and employment law. He is the immediate past chair of the City of Houston Municipal Employees’ Civil Service Commission and serves on the editorial board of The Houston Lawyer.

Allowing Illegal Drug Culture to Flourish at Work Does Not Create Employer Tort Liability

By Scott Lemond

Do Texas employers owe the public a duty to keep it safe from “mentally unstable,” drug-crazed workers? Generally, no. In Loram Maint. of Way, Inc. v. Ianni, 48 Tex. Sup. Ct. J. 1047 (Jun. 30, 2006), the Texas Supreme Court reversed an $800,000 actual/$500,000 punitive damages award for negligent retention and supervision of a “moody” and “unstable” methamphetamine user.

Police Officer David Ianni sued Loram, a railroad track maintenance company, after Roger Tingle, a Loram employee, shot Ianni. Loram had permitted “an illegal drug culture . . . to flourish among the employees” with Tingle, “an enthusiastic participant,” often not sleeping for days and taking drugs just “to be awake enough to work.” Loram officials even gave Tingle time off to buy drugs.

As methamphetamine took its toll on his body, Tingle became violent. Loram received reports that he threatened his wife’s friend with a knife.1 In particular, on the day Tingle shot Ianni, Tingle told coworkers that he had previously attacked his wife. Nevertheless, Loram took no action. Instead, company officials simply drove him to his motel after work. About an hour later, Tingle pulled a firearm on his wife. When Ianni, who observed the incident, intervened, Tingle shot him.

After addressing a procedural issue,2 the court acknowledged that a “narrow duty” exists to control the off-the-job conduct of one’s employee, but only to the extent that the employee commits a tort (i) on the employer’s premises or (ii) using property that belongs to the employer. With respect to incapacitated employees, an employer who chooses to exercise control over the employee, must not “worsen the situation.”

Using these principles, the court distinguished Otis Eng’g Corp. v. Clark, 668 S.W.2d 307 (Tex. 1983). A duty existed in Clark because the employer suggested to an impaired worker that he drive home. The duty arose, “not because of mere knowledge of intoxication, but because of the employer’s negligent exercise of control over the employee.” In Ianni’s case, however, no evidence indicated that Loram exercised control over Tingle by the time of the shooting and mere supervisory knowledge that Tingle was high and left work in an agitated state was not enough to impose liability.

The court also distinguished Texas Home Mgmt. v. Peavy, 89 S.W.3d 30 (Tex. 2002), in which a facility for mentally-impaired residents was found to have a State-imposed obligation to control the behavior of its residents. Such relationships, said the Court, are “significantly different” than employer-employee relationships which are usually limited to a specific task or period of time. For these reasons, a unanimous supreme court reversed and rendered judgment in favor of Loram.

1. Railroad track maintenance requires travel; therefore, Loram paid for motel rooms to house the workers and their families.   2. The Supreme Court’s previous decision to deny Ianni’s petition for review did “not give any indication of this Court’s decision on the merits of the [employer’s duty] issue.” Consequently, the “law of the case” doctrine did not apply.

Scott Lemond is of counsel in the Houston office of Seyfarth Shaw, LLP, where he concentrates his practice in the areas of litigation and labor and employment law. He is the immediate past chair of the City of Houston Municipal Employees’ Civil Service Commission and serves on the editorial board of The Houston Lawyer.

When a Defendant Loses Its Citation, Is All Hope Lost?

By Robert Painter

In Fidelity and Guaranty Insurance Company v. Drewery Construction Company, Inc., 186 S.W.3d 571 (Tex. 2006), the supreme court reviewed a default judgment, where a plaintiff claimed that its registered agent, who had been served, failed to properly forward the citation and petition.

Fidelity used Corporation Service Company (CSC) as its registered agent.  Drewery served CSC, but Fidelity claimed it never received the petition and citation from CSC, and CSC had no records to show that it sent them to Fidelity.

After Drewery received a default judgment, Fidelity moved for a  new trial which was denied by the trial and intermediate appellate courts. In its opinion, the supreme court ratified the well-settled Craddock elements, which require a new trial when a party shows (1) default was neither intentional nor consciously indifferent, (2) there was a meritorious defense, and (3) a new trial would not cause delay or undue prejudice. SeeCraddock v. Sunshine Bus Lines, 133 S.W.2d 124, 126 (Tex. 1939).

This case hinged on the first Craddock element.  To address this point, Fidelity attached four affidavits to its motion for new trial.  The affidavits established that Drewery served CSC and that the Fidelity agent who should have received the petition and citation from CSC never did so. The affidavits also discussed CSC’s procedures for handling service documents, and its document retention policy, which explained why CSC’s records concerning this case had been destroyed. 

Reversing the lower court, the supreme court ruled that Fidelity’s affidavit evidence was sufficient, because it detailed the general procedures the parties used for handling service papers and the specific facts known about the Drewery service papers. The opinion rejected the lower court’s requirement that there must be an affidavit from the person who lost the service papers detailing how the loss occurred, making the observation that it is impractical, because quite often people do not who how they lost the service papers in the first place.

Before finding in Fidelity’s favor on this point, and reversing the trial court, the supreme court rejected Fidelity’s two other grounds. First, the court distinguished a motion for new trial from a restricted appeal, the latter of which is limited to errors apparent on the face of the record. In a motion for new trial, a party may introduce evidence to explain why default occurred. In this case, even though part of Fidelity’s full name was omitted in the style of the service documents, it was undisputed that its registered agent was properly served. Thus, the partial omission of Fidelity’s name in the service papers is only relevant to the Craddock analysis. Second, Fidelity argued that the default should have been set aside because it was served with Drewery’s original petition, which was amended before the default judgment. Relying on established precedent, the supreme court rejected that argument because the amended petition did not seek a more onerous judgment that the original pleading.

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